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That first rule in fishing has always been fish where the fish are and the second rule of fishing has always been don't forget rule number one. What the hell are you thinking about? It's weird and what's happened of course is that we're standing a bit for some combination of basic morality and sturdy common sense.
And it's amazing how well Berkshire Hathaway and the Daily Journal for that matter have succeeded with nothing more than basic morality and sturdy common sense. Of course, when people talk about common sense, they mean Uncommon Sense. Every time you hear that somebody has a lot of common sense, it means he's got uncommon sense.
So, it's harder to have common sense than it is generally thought. Let me give you an interesting example. In the investment world, people get involved with enormous amount of high IQ people be more trying to be more skillful than normal. I hardly imagine another activity that gets so much attention.
And weird things have happened. And years ago, one of our local investment counselling shops a (very big one) … they were looking for a way to get an advantage over other investment counseling shops and they were doing something as follows. We've got all these brilliant young people from Harvard and so forth and they worked so hard trying to understand business and market trends and everything else.
And if we just ask each one of our most brilliant men for their single best idea then created a formula with this collection of best ideas, we would outperform averages by big amount. And that seemed plausible to them because we were well-educated. That's what happens when you go to Harvard and Wharton.
So they tried it out and of course it failed utterly. So try it again. And it failed utterly. And they tried the third time and it was also failed. What they were looking for is the equivalent of the Alchemists of centuries ago who I wanted to turn lead into gold. They thought if you could just buy a lot of lead, wave a magic wand over and turned into gold, that would be a good way to make money.
Well, what this counseling shop was looking for is the equivalent of turning lead into gold and of course it didn't work. I could have told them but they didn't ask me nothing. The interesting thing about this situation is this is a very intelligent group of people that's come from all over the world.
You've got a lot of bright people from China where people tend to average out a little smarter. And the issue is very simple. there's a simple question. Why did that plausible idea fail? just think about it for a minute. You've all been to fancy educational institutions. I bet you there's hardly a one in the audience who knows why that thing failed?
That's a pretty ridiculous demonstration I'm making. How can you not know that? It's one of the main activitiesof America, an obvious important failure, surely we can explain it. You have to have stayed awake in your freshman college courses to answer that question. But if you ask that question at the Department of Finance at a leading place, the professors wouldn't answer correctly.
I’m not going to leave you that question because I want you perplexed. I will go on to another issue. But that's when you should be able to answer it. It shows how hard it is to be rational on something very simple. Part of it is how many kind of crazy ideas people have and they don't work. You don't even know why they don't work even though it's perfectly obvious If you've been properly educated.
And by the way my definition of being properly educated is being right when my professor is wrong. Anybody can spit back what the professor tells you. The trick is to know when he's right and when he's wrong, that's the perfectly educated person. Of course, they're frequently wrong particularly in the soft sciences.
In fact, if you look at a modern elite Institution, it's fair to say that a lot of the faculty are a little crazy. It’s left-wing now in the humanities. And it's very peculiar, that's another thing. Why should 90 percent of the college professors and the humanities to be very left-wing. I leave that question for you too.
But it happens. Another issue of course that's happened in the world of stock picking where all this money and effort goes into trying to be rational is that we've had a really horrible thing happened to the investment counseling class. And that is these index funds have come along and they basically beat everybody.
And not only That, the amount by which they beat everybody is roughly the amount of cost of running the operation and making the changes in investments. So, we have a whole profession is basically being paid for accomplishing practically nothing. This is very peculiar. This is not the case with bowel surgery or even the criminal defense bar and the law or something.
The whole profession with their chosen activity they have selected, they can't do anything. Now, in the old days the people in the profession always had some of this problem and they rationalized as follows. We are saving our clients from the insurance salesman and the standard stock broker who serves the active traders.
And they were saving people from the life insurance salesman and the hustling stock brokers. And I suppose in the sense that the investing class is still saving those people from an even worse faith. But it's very peculiar with a whole profession that worked so hard and is so admirable and the members of which we are delighted when they marry into our families and they just can't do what they are really trying to do: which is get better than average results.
How is that profession and this terrible situation? As index investing gets more and more popular and including by a lot of fancy places, I’m giving this very simple answer. They are handling it with denial. They have a horrible problem they can't fix, so they treat it as non-existent. This is a very stupid way to handle a problem.
Now it may be good when you're thinking about your own death which you can't fix and just denial all the way to the end. But in all the practical fields of life, this problem thoroughly understood is half-solved or better coped with. So it's wrong to have all these people in just a state of denial doing what they've always did year after year and hoping that the world will keep paying them even though an unmanaged index is virtually certain to do better.
It's a very serious problem. Think of how much New York, say, needs a flow of money from finance. Think of what will happen to Manhattan if there weren’t any fees from investment management or trading spreads and so on. So, it's a weird situation. And of course it's unpleasant. Big investment counseling shops: some of them shrink and some of them go out of business.
And the value investors of course who many I know because we came from that tradition, the value investors who are honorable are quitting - boom boom boom. And what worked for them for years stopped working and they're honorable people, they just quit. And they're also rich, that makes it easy but those who aren't rich, you have a hell of a problem.
It costs about fifty thousand dollars to stay in Manhattan to send your children to preschool, not-deductible. And that's just the start of an endless recession of years of mass expense. So if your game is money management, you have a serious problem. I don't have any solution for this problem. I do think that index investing if everybody did it, it won't work.
But for another considerable period, index investing is going to work better than active stock picking where you are trying to know a lot. Another place like Berkshire Hathaway or even the Daily Journal, you've done better than average. Now there's a question: why has that happened? Why has that happened?
And the answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace, utilities and so on and so on and so on. We never had that dream. But we never thought we could get really useful information on all subjects like Jim Cramer pretends to have.
And we always realized that we worked very hard, we can find a few things where we were right. And the few things were enough. And that was a reasonable expectation. That is a very different way to approach the process. And if you would ask Warren Buffett the same thing that this investment counseling did: give me your best idea this year.
And you just followed Warren's best idea, you would find it worked beautifully. But he wasn’t trying to know a whole world. He would give you one or two stocks. He had let more limited ambitions. I had a grandfather, he was very useful, my mother's grandfather. And he was a pioneer and he came out to Iowa with no money but youth and health.
And took it away from the Indians in the black war. He was a captain in the Blackhawk Wars. And stayed there and he bought cheap land and he was aggressive and intelligent and so forth. And eventually he was the richest man in the town, own the bank, highly regarded, a huge family and a very happy life.
And he had the attitude having come out to Iowa when the land was not much more than a dollar an acre and having stayed there until that black topsoil created the modern rich civilization and some of the best land in the world. His attitude was that a favored life like his when you were located in the right place, you just got a few opportunities in you live until 90.
The trick was seizing on these that were your fair share that came along when they did. And he told that story over and over again to the grandchildren around him all summer. And my mother who had no interest in money remembered the story and told it to me. But I'm not my mother's natural imitator and I knew grandpa was right.
And so I always knew from I was a little boy, the opportunities that were important, that were going to come to me were few, and the trick was to prepare myself for seizing the few that came. This is not the attitude they have at big investment counseling thing. If they study a million things, they can know a million things.
And that of course the result is almost nobody cannot perform an index. Whereas I sit here with my Daily Journal stock, my Berkshire Hathaway stock, my holdings in LI Lu’s Asian fund, Costco stock, of course I'm out performing everybody. I'm 95 years old. I practically never have a transaction. And the answer is I'm right and they're wrong.
And that's why it's worked for me and not for them. And the question is do you want to be more like me or more like them? The idea of diversification makes sense to a point if you don't know what you're doing and you want the standard result and not be embarrassed but of course nobody's entitled to a lot of money because it's a truism.
It's like knowing the two and two equals four. And the investment professionals think they're helping you by arranging a diversification. Any idiot could good diversify a portfolio and or a computer for that matter. But the whole trick of the game is to have a few times when you know that something is better than average and invest only where you have that extra knowledge.
And then you get there's a few opportunities, that's enough. And what do you care if you own a few securities and JP Morgan Chase owns a hundred? You know, what's wrong with owning a few securities? Warren always say if you lived in a growing town and you owned stock and three of the best enterprises in the town, isn't that diversified enough?
The answer is of course! It’s they're all wonderful places. And that Fortune's formula which got so famous which was a formula to tell people how much to bet on each transaction if you had an edge and of course the bigger your edge, the more close the transaction was to a certain winner, the more you should bet.
And of course, there's mathematics behind it. But of course, it's true, it's perfectly possible to buy but only one thing because the opportunity is so great and such a cinch or only two or three. So, the whole idea of diversification when you're looking for excellence is totally ridiculous. It doesn't work.
It gives you an impossible task. What fun is it to do an impossible task over and over again? I find it agony. Who would want to do it? And I don't see why. My father had a client, he was a lawyer in Omaha. He had a client whose husband had a little soap company. And the guy died and my father sold the soap company.
This woman was one of the richest people in town in the middle of the depression. What she had was a little Soap Company, the biggest mansion in Omaha’s best neighbourhood. And he sold this soap company she had a mansion in the best neighborhood and three hundred thousand dollars. Three hundred thousand dollars in 1930 something was an incredible amount of money, a little hamburger was a nickel, a big hamburger was a dime and the all-you-can-eat café enough to feed you to stay alive for two bits a day.
I mean three hundred thousand. Well, she didn't hire an investment counsellor, she didn’t do anything. She's a wonderful old woman. And she just took that and she divided it into five chunks and she bought five stocks. I remember three of them because I probated her estate. One was General Electric, one was Dow, one was Dupont, I forgot the other two.
And she never changed those stocks. She never paid any advisors, she never did anything, never spend her income, she bought some municipal bonds. And by the time she died in the 50s, she had a million and a half dollars, no costs no expenses. I said how did you decide to do that? And she said, well, she said: I thought electricity and chemistry were the coming things.
She just chunk it all in and sat on her ass. I always liked that little woman, my kind of a girl. But it's rare, you know. But you stop to think about it, think of all the expense and palaver that she didn't have to listen to. And all the troubles she avoided, zero costs. Of course, but people don't realize because they're so mathematically illiterate.
If you make five percent and pay two of it to your advisors, you're not losing 40 a year future. You're losing 90 percent. it was over a long period of time that little difference that cause a 90 disadvantage to you. So it's hugely important for somebody who's a long-term holder not to be paying a big annual toll out of the performance.
And of course, there are a few big-time advisors now who are using indexation very heavily. Of course, they're prospering mightily and of course every time they get somebody it's just agony for the rest of the investment counselling. And it's very serious problem and I think these people who are used to winning, these old-time value investors who are now just getting into profession that's a very understandable thing to do.
I regarded as more noble thing than staying in, you know play along with the denial. It's an interesting problem. You can see I'm trying not trying to make your morning. I'm just trying to describe things the way they are. If you take the modern world where people are trying to teach you how to come in and trade actively in stocks.
Well, I regard that as roughly equivalent to trying to induce a bunch young people to start off on heroin. it is really stupid.
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